30 September 2025
A common misconception in the investment industry is that the selection of an endowment is all about its tax advantages. However, there are numerous additional gems locked up in the endowment arena.
This investment vehicle comes in different shapes, and not all five-year policy structures are endowments. An endowment policy is a type of life insurance policy that pays out a lump sum after a specific term or on the death of the life assured, whichever comes first. However, not all five-year policies have life assureds – some, like sinking funds, only have policy owners. Although endowments and sinking funds share many commonalities, each is designed for a specific purpose, and each has very specific benefits.
The major difference between an endowment and a sinking fund is the presence or absence of a life assured. Many of the benefits of these two products revolve around this matter and financial advisers should be cognisant of the differences.
Shared characteristics of endowments and sinking funds
Endowments and sinking funds both:
- Have a restricted 5-year term.
- Have policy owners.
- An endowment will also have a life assured
- Have some form of inheritance
- Can, in the presence of a beneficiary or nominee, escape executor’s fees
- Are underwritten by a life company
- Deduct taxes within the product
- Taxed according to the five-fund principle.
- Interest at 30%
- Dividends witholding tax at 20%
- Capital gains at 12%
- Must adhere to Regulation 54 of the Long-term Insurance Act
- Allow one loan and surrender/ partial surrender within the restricted period.
- The maximum withdrawal is limited to all premiums plus 5% composite growth
- Enforce an ad-hoc premium restriction of 120% to avoid extending the five-year restricted term.
- All contributions in year one is the first premium. Additional contributions can then be made in the ensuing years on the principle that annual contributions may not exceed 120% of the highest annual premium of the previous two years. Once two years have been missed, no additional contributions may be made.
- Allow a tax-free income from the product once the restricted period has passed.
- Growth, however, will still be taxed within the policy.
With such a list of similarities, it is not surprising that many clients and some advisers consider endowments and sinking funds to be the same.
Beneficiaries and nominees
A sinking fund only has a policy owner, who may only nominate another policy owner (only one) to continue with the sinking fund should he/she pass away. The inheritance is therefore in the form of a policy (The policy does not cease to exist and needs to finish the 5-year term). The new owner, however, will be allowed to withdraw the benefit in line with the premiums-plus-5%-composite-growth rule. If there is no nominee for ownership, the policy will complete the restricted period and then pay out to the owner’s estate.
In an endowment the policy owner, who is also the life assured (there may be more than one life assured), may appoint one or more beneficiaries. At death, the policy proceeds pay out according to the beneficiary list as cash. If there are no beneficiaries, the proceeds will be paid to the estate.
The tax benefit
Since an endowment has a fixed rate of 30% tax on interest and 12% on capital gains, this is often the primary basis for consideration of such a structure. Obviously, for individuals with a marginal rate of more than 30% and trusts with a 45% fixed rate and 36% CGT rate (80% capital gains inclusion), the use of an endowment or sinking fund for the tax benefits become appealing.
Furthermore, the benefit of keeping the same tax rate after five years while a tax-free income can be taken, makes sense from a tax planning point of view. However, many advisers regard this as the only benefit.
But wait, there is more…
Liquidity at death
One of the biggest advantages of an endowment structure for individuals is the liquidity at death, if one or more beneficiaries have been appointed. Any investment outside an endowment structure (like unit trusts, bank deposits, shares, and property) will revert to the estate. With some estates taking years to be completed, it means the legitimate heirs according to the will, might have to wait for either the estate to be wound up, or the executor to allow some investments to be transferred once sufficient liquidity in the estate has been determined.
With an endowment, the beneficiaries will receive a cash payment within weeks (unless foul play is suspected). This means that a spouse, who was dependent on income from the late spouse, will have almost immediate liquidity to generate an income. Many clients do not take this liquidity constraint on investments inherited via a will, into consideration.
Even if the tax benefit is not there, the liquidity benefit can resolve liquidity issues after death, making it a valuable estate planning tool.
Protection against creditors
This benefit is limited to endowments only, as legislation offers protection against creditors to all policies with a life assured.
- After three years, 100% of the capital, including contributions after year three, will be protected against creditors.
- This protection will continue for another five years after termination of the endowment.
- The termination may be due to death, in which case the beneficiaries will have the same protection for the five-year period.
- The protection will include any capital or non-capital investments and that the life assured or beneficiaries acquire with the proceeds. This implies that if a child, as beneficiary, purchases a property with the proceeds only, the property will be protected against creditors.
For farmers and businessmen this benefit is vital when setbacks occur, as the proceeds of the endowment can be used to start over. Not enough businessmen and farmers are fully aware of the value of this protection against total bankruptcy.
Sinking funds do not have a life assured
Trusts often face the dilemma that if they make an investment in an endowment, there might be estate duty implications for the life assured. Furthermore, should the life assured pass away, the endowment is forced to liquidate, which might not be the desired outcome. In a sinking fund the trust can be the owner (on the condition that all beneficiaries of the trust are natural persons), and there is no life assured to create complicated scenarios.
Diversify risk away from core activity
Many business owners and farmers often concentrate their wealth within the industries they know best, leading to significant concentration risk. By diversifying a portion of their private into external investments, they can mitigate that risk and enhance financial resilience. Allocating these to an endowment structure further strengthens protection by shielding them from industry-specific risk, as outlined above.
Although the tax benefits of endowments are important, a decision to put money into an endowment reaches way beyond a pure tax calculation. All the advantages above need to be taken into account to get a balanced view on whether an endowment or sinking fund might be the correct financial advice.
